Plunging Stock Prices Are Good Recession Predictor

Equity price drops have long been dismissed as a reliable harbinger of recessions. Nobel-winning economist Paul Samuelson famously quipped in 1966, “The stock market has forecast nine of the last five recessions.”

But economists have largely focused on indicators relative to an entire recession, and that may have skewed the data.

By looking at a variety of indicators in relation to just the start of major economic downturns over the last 40 years, however, International Monetary Fund economists John Bluedorn, Jörg Decressin and Marco Terrones show that “equity prices are particularly useful predictors of recessions.”

“Changes in equity price have better in-sample forecasting performance than many of the other commonly featured recession predictors, including the term spread,” the trio said.

Although there’s a high correlation to major falls in house prices with recessions, not all recessions have major price declines in the housing market.
And oil price movements are often associated with supply-side factors rather than simply demand, making it a crude recession forecaster.

The study also found that market uncertainty could also be a useful tool in predicting long-lasting contractions.

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